Friday, June 19, 2009

Business Strategy & Supply Chains

[Click here to learn more about my book on Enterprise Supply Chain Management or to buy it.]

What do supply chains have to offer to the business strategy? It turns out, a lot.

To understand, let us review some of the basic concepts of strategy. Strategy was initially postulated as a balancing act between the external and internal forces in a corporation where the firm matched its (internal) strengths and weaknesses against the (external) opportunities and threats. Since then, many researchers have added their own work to the field of defining what is corporate strategy, how to think about it, how to formulate good strategy, and have provided various frameworks to help the evolution of the concept of corporate strategy. In short, the goal of any corporate strategy is to create competitive advantages for the business in its industry segment so that it is well-positioned for financial success.

Porter’s three generic strategies

Porter’s three basic strategies were suggested by him in 90s and have become a mainstay of the strategy literature. These three strategies are based on pursuing cost, differentiation, or focus as the main strategy and then adopting the policies, investments, and projects around that. The cost strategy is based on pursuing the cost leadership so that the firm has a definite cost advantage over the competition. If the firm is successful in achieving cost that is below the average cost of products/services offered in a segment, then it allows the firm to either be more profitable or expand its market share. Differentiation strategy postulates that firms can have competitive advantages over the others in their segment if they can image develop unique features in their products or services that are valuable to its customers. Of course, for this strategy to work, the cost of developing these unique features must be less than the premium that the buyers are ready to pay for these features. The third generic strategy is the focus strategy that primary postulates creating a niche within the segment to achieve competitive advantage. These niches are created when the product is specifically designed and targeted at a well defined customer segment. The firm must identify the customer segment it wants to target and then define the unique features that will be valuable to this segment – note that cost itself may be one of those unique features that appeal to this segment, so can be other product features. There are many styles of strategies now defined that are primarily combinations and variations of these three generic strategies. That makes sense because a company may adopt different strategies for different business units or products depending on its current positioning in that segment, its strengths, available resources, and skills required to address the demands of a strategy.

Resource based view of strategy

A Resource-based View (RBV) of the competitive advantages emerged on the premise that it is only the resources of a firm that create the competitive advantages. When a firm possesses resources that are unique to it and can create value for its buyers, then the firm has competitive advantages. These resources can be direct such as cash and assets, indirect such as brand value, or firm’s capabilities such as its supply chain processes.

Capability based view of strategy

Then, there is the concept of competing on capabilities. This became a prevalent way of thinking about strategy after some Harvard researchers provided examples using Wal-mart and how its capabilities won the company the top spot in its industry segment.

It is a little ironic that capabilities came last in the evolution of thinking on corporate strategy since this is so basic to the success of corporations as well as to the successful implementation of any strategy the firm may have picked up to pursue. After all, any strategy that remains unexecuted does not deliver. Executing a strategy necessarily means that firms create capabilities that are demanded by the strategy. Take, for example, the cost strategy that Wal-mart has followed since its inception – it is the capabilities that Wal-mart developed to pursue the low-cost strategy that allowed it to reduce costs across its value chain. If Wal-mart was unable to create and maintain such functional capabilities then simply having a strategy to pursue low costs does not do any good. To pursue low cost, Wal-mart analyzed its whole value chain and developed capabilities in all business functions where such potential existed – such as store operations, distribution, warehousing, inventory management, and even merchandising functions such as seasonal merchandise and pricing optimization.

The same remains true for any other strategy that a firm might select. For example, differentiation strategy may lead to developing capabilities in product design, manufacturing, delivery, or customer service. Consider Kindle: this is a clear example that has propelled Amazon to develop capabilities in innovative product design which was not its mainstay as a retailer! Also consider the delivery model of the books using Kindle that provides another clear differentiator to Amazon compared to its competitors.

While the resource strategy considers direct and indirect resources as enabling competitive advantages and that is true, the fact is that these resources themselves are a result of functional capabilities that, over time, have delivered these resources in addition to their direct contribution to creating the competitive advantages. If Coke as a brand is valuable today, it is because the company developed superior marketing capabilities in the past years that have consistently worked towards creating the brand that now can be leveraged as a competitive advantage. Same is true for cash assets that Wal-mart may have – these assets themselves are a result of their functional capabilities allowing cost reduction rather than the other way around. Therefore, I see the direct & indirect resources simply as byproducts of a successful strategy that drives functional capabilities to create competitive advantages and also delivers these benefits in terms of direct/indirect resources which can be leveraged in advancing these competitive advantages. Remember that these resources alone are not sustainable by themselves and continue to depend on the original functional capabilities that created them in the first place.

The capabilities based competitive advantages, therefore, just happens to be the core precept of creating and maintaining strategic edge in an industry.

What do the supply chains have to offer to corporate strategy?

Now that we have refreshed the basic concepts of strategy, let us see what can supply chains offer to corporate strategy? Supply chains primarily focus on the operations of a firm; supply chain council defines the five basic supply chain functions as Plan, Source, Make, Deliver, and Return. Depending on the industry you are in, all or some of these functions will be part of your supply chain. All the supply chain functions primarily offer the firm cost reduction opportunities directly or indirectly. Supply chain functions like warehouse automation and transportation optimization direct reduce their cost of goods sold (COGS), and other functions like inventory optimization reduce the requirements for working capital thus increasing return on assets (ROA). All these options provide opportunities for creating competitive advantages for a firm. These supply chain functions can direct affect the cost basis and provide the firm with the cost advantages. You can read more about the financial impact of supply chain functions in this article here.

Then, there are other supply chain functions that can provide differentiators through process integration, such as those in the order fulfillment area. These functions not only add to the operational efficiency but can also provide differentiation in customer service through perfect order fulfillment and ability to track and communicate the customer order status throughout the fulfillment process.

Better planning through better demand forecasting can affect all the operations in a supply chain in a made-to-stock or retail situations. These planning functions can substantially reduce the cost basis by reducing inventory, increasing manufacturing operations efficiency, increasing distribution operations efficiency, and in reducing plan volatility that stabilizes the operations.

Optimization based supply chain solutions such as manufacturing planning, scheduling, and sequencing; inventory optimization, transportation optimization, purchase planning, etc. make use of powerful mathematical models to represent the real-life supply chain constraints with the objective of reducing cost or increasing throughput. Both of these (reducing cost or increasing throughput) can help organizations create and sustain competitive advantages by creating cost, delivery, and customer service differentiators.

Summary

Firms should analyze their corporate strategies and dissect their value chain (operations) to establish the functional capabilities that will help them achieve the goals set by such strategies. Supply chain functions, specifically, provide many such opportunities and combined with standard packages solutions can help the companies achieve their strategic goals systematically when these efforts are aligned with the strategic goals through the identification of required functional capabilities.

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